Presentation Speech by Professor Karl-Göran Mäler of the The Royal Swedish Academy of Sciences has decided to Royal Academy of Sciences
Translation from the Swedish text
Your Majesties, Your Royal Highnesses, Ladies and Gentlemen,
This year’s prize in economics has been awarded for contributions to a topic which lies at the very core of the science, the theory of general equilibrium. Briefly described, this theory concerns the way in which apparent economic disorder gives rise to an orderly system and how it is that seemingly independently made decisions, all motivated by self interest, can become coordinated and lead to something which can reasonably be called order. Consider the large numbers of both firms and households which make, on a daily basis, an extremely large number of decisions regarding purchases and sales of goods and services. There is certainly good reason to pause in wonder that one can in general buy that which one had planned to buy and sell that which one had planned to sell. By some means, these numerous, individually made economic decisions have been coordinated. This phenomenon is so much a part of everyday life, that one generally does not stop to consider it, a fact which makes it none the less remarkable.
Adam Smith offered an explanation of this coordination of the decisions of firms and households in terms of the price system. Prices transmit information about demands for goods and services to the producers and information about costs of production to consumers. It is this transmission of information which enables order rather than chaos to characterize our economic system.
During the latter half of the 19th century, a mathematical formulation of this theory was rendered by a Frenchman, Léon Walras. Economics thereby obtained the first general equilibrium theory. It was general in the sense that it encompassed all markets for goods, services and factors of production. It was a theory of equilibrium because it explained how the quantities, demanded and supplied, become equal in each of these markets.
Walras’ theory was of fundamental importance for subsequent development in economics. In spite of its significance, not until the 1920’s were serious efforts made to determine the logical consistency of this theoretical model. Does there exist some set of prices which equilibrate all markets simultaneously? Do the equations which comprise Walras’ model have any meaningful solution?
This question was answered in the affirmative by the research of Abraham Wald during the 1930’s. It was unfortunately necessary for him to make unrealistic assumptions in order to prove the existence of an equilibrium. For this reason, these results did not lead immediately to further research.
Not before 1954 did the question of the internal logical consistency of general equilibrium theory receive a rigorous answer. It was then that Professors Kenneth Arrow, who received the Nobel prize in economics in 1972, and Gerard Debreu, who is to receive the prize today, wrote the now classic article, “Existence of an Equilibrium for a Competitive Economy”. Professor Lionel McKenzie should be mentioned here as well, due to important contributions which were made by him concurrently.
In the theory which was developed by professors Arrow and Debreu, and which is now known as the Arrow-Debreu model, a set of conditions was outlined which guaranteed the existence of a general equilibrium. In a series of exceptionally important works during the following decade Professor Debreu succeeded in proving the existence of a general equilibrium under less stringent assumptions. And yet, this research was not limited to the question of the existence of an equilibrium. Professor Debreu had proceeded to analyze the uniqueness of such an equilibrium as well as the normative characteristics associated with competitive equilibrium.
Let us return once more to Adam Smith and his proposition that from the striving by individuals to maximize their own welfare emerges an invisible hand by which an economic system is guided to obtain the greatest possible welfare for society. Kenneth Arrow and Gerard Debreu have, independently of one another, established conditions which guarantee that the price mechanism brings about an efficient utilization of resources in accordance with the desires of consumers. I would like to emphasize that this does not necessarily imply a recommendation for laissez-faire. The theory describes a set of conditions which are sufficient for economic efficiency. There remains the empirical task to assess the extent to which these conditions are fulfilled in an actual economic system.
The formulation of general equilibrium theory for which Professor Debreu bears the primary responsibility is characterized by important generality. Originally, it was a theory of competitive equilibrium for an economy without a public sector and without uncertainty. But the advances in the theory achieved by professor Debreu have enabled its application to the analyses of uncertainty, collective goods and taxes related to the public sector, environmental problems and so forth. In addition, the theory provides an essential frame of reference for economic cost-benefits analysis. An even broader spectrum of applications has been forwarded by the creation of so-called computable general equilibrium models. These empirical models build directly on Gerard Debreu’s formulation of general equilibrium theory and may be used for problems requiring analysis of entire economic systems, such as those pursued by the International Monetary Fund:
In the development of the general equilibrium theory, Professor Debreu has not merely given us information about the price mechanism, but also introduced new analytical techniques, new tools in the toolbox of economists. Gerard Debreu symbolizes the use of a new mathematical apparatus, an apparatus comprehended by most economists only abstractly. Nevertheless, his work has given us an improved intuitive understanding of the underlying economic relevance. His clarity and analytical rigor, as well as the distinction drawn by him between an economic theory and its interpretation, have given his work important bearing on the choice of methods and analytical techniques within economic theory on a par with any other living economist.
You have contributed more than anyone else to our understanding of general equilibrium theory and the conditions under which there exists a general equilibrium in an abstract economy. Your insightful analysis of models of abstract economies have provided us with a general theory which may be applied to a multitude of problems offering a much broader understanding than alternative partial models could allow.
More than anyone else, you are a symbol of a new approach to economic analysis, an approach that, while highly abstract, yields a better intuitive understanding of the basic economics. Your influence on methods, standards, and analytical techniques used by economists has been outstanding.
On behalf of the Royal Academy of Sciences I wish to convey to you our warmest congratulations, and now I ask you to receive your prize from the hands of His Majesty the King.